Why Now is the Time for a Strategic Net Worth Analysis
Capital is the core of an institution’s ability to grow and succeed. This is especially true in the current environment as depositories of all sizes consider the potential impacts of COVID-19, cybersecurity failures, recessions and other risks. Yet answering the question: “How much capital does my institution really need?” remains a challenge for many leaders.
Now is the time to develop or refine your strategic road map to include capital adequacy and identify potential risks. Understanding how operational and credit risks could impact the balance sheet and income statement will enable your depository to determine the appropriate amount of capital. This is critical for your business, whether it is a regulatory requirement or not.
| Prioritizing a Strategic Net Worth Analysis How can busy executives ensure the most effective use of their time? Categorizing their priorities. Most of us follow some form of this useful practice: Make a list of projects and initiatives that we “must do,” “might consider doing” and “don’t need to do.” For many, stress testing net worth often falls into the second category. While the largest credit unions must regularly perform capital stress testing, many who don’t fall into that class wonder about the tradeoff between the time and value of this task. Financial regulators require capital stress testing for institutions with more than $10 billion in assets, but we’ve found it to be an important exercise for financial institutions of any size. Regular stress tests aim to ensure financial depositories have enough capital to withstand a severe economic downturn, including the ability to quickly adjust their balance sheets. Institutions do not need to follow the same rigorous mandate required for $10 billion institutions in order to inform appropriate levels of capital. Why Conduct Stress Tests? Stress testing offers key insights about the credit union’s financial position that exceed regulatory requirements, making them a good idea for all depositories; a comprehensive examination of the balance sheet and various potential risks forces the credit union to take a hard look at its current position and how that would change under various scenarios. Here are some of the benefits derived from a detailed stress testing analysis:· Assurance that your credit union has adequate capital to survive a market downturn· Verification of the adequacy of the allowance for loan and lease losses· Ability to isolate possible future problems, such as an over-concentration in a specific asset type· Better decision-making as management and the board see the need to set risk-tolerance levels· Improved capital and asset planning by verifying risk-reward assumptions |
| How to Conduct Stress Tests Although establishing and executing a capital stress testing process takes time to establish, credit unions can potentially benefit by developing an organized approach that helps keep the program moving smoothly. Here are some points to consider: 1. Data collection and organization – Before the advent of capital stress testing requirements, many depositories didn’t keep the necessary critical data on their loan originations – often the biggest challenge to adequate testing. Results from an analysis will be far less meaningful if the appropriate data isn’t available – as the IT expression goes, “garbage in, garbage out.” Creating and developing a process to collect and organize data is essential to evaluate your credit union’s profitability, value, and overall balance-sheet trends. Knowing that the input data is accurate allows management and the board to be confident in the results of analyses, permitting them to plan strategies more effectively for future success. 2. Scenarios – Scenario simulations are a beneficial exercise for all institutions. As part of stress testing, the Fed issues scenarios that incorporate a baseline status, as well as those assuming adverse and severely adverse economic environments. The resulting analyses determine how well the depository will perform in the face of a deteriorating market. By definition, risk involves unknown factors that can occur and affect the value of each product. Reviewing the portfolio under different scenarios may allow financial managers to more accurately price and invest in risk, ensuring the credit union is fairly compensated. For the best insight, scenario testing should include more than balance-sheet risk and valuation. Because liquid, short-term liabilities fund long-term assets, they carry liquidity risk and the possibility that funding could quickly dry up. We believe this makes it imperative to perform periodic stress testing of liquidity funding. The testing scenarios should include local economic actions, like increases in competition or a decrease in skilled workforce, as well as global economic....--> Capital is the core of an institution’s ability to grow and succeed. This is especially true in the current environment as depositories of all sizes consider the potential impacts of COVID-19, cybersecurity failures, recessions and other risks. Yet answering the question: “How... |